Reverse takeover

A reverse takeover (RTO), reverse merger, or reverse IPO is the acquisition of a public company by a private company so that the private company can bypass the lengthy and complex process of going public.[1] Sometimes, conversely, the public company is bought by the private company through an asset swap and share issue.[2] The transaction typically requires reorganization of capitalization of the acquiring company.[3]

Process

In a reverse takeover, shareholders of the private company purchase control of the public shell company/SPAC and then merge it with the private company. The publicly traded corporation is called a "shell" since all that exists of the original company is its organizational structure. The private company shareholders receive a substantial majority of the shares of the public company and control of its board of directors. The transaction can be accomplished within weeks.[4]

The transaction involves the private and shell company exchanging information on each other, negotiating the merger terms, and signing a share exchange agreement. At the closing, the shell company issues a substantial majority of its shares and board control to the shareholders of the private company. The private company's shareholders pay for the shell company by contributing their shares in the private company to the shell company that they now control. This share exchange and change of control completes the reverse takeover, transforming the formerly privately held company into a publicly held company. Depending on the underwriters' agreements and other forward purchase agreements, the size of the company taken public in a reverse merger can exceed the market capitalization of the shell company/SPAC by a considerable amount.[5]

In the United States, if the shell is an SEC-registered company, the private company does not go through an expensive and time-consuming review with state and federal regulators because this process was completed beforehand with the public company. However, a comprehensive disclosure document containing audited financial statements and significant legal disclosures is required by the Securities and Exchange Commission for reporting issuers. The disclosure is filed on Form 8-K and is filed immediately upon completion of the reverse merger transaction.

Benefits

Flexibility

Going public through a reverse takeover allows a privately held company to become publicly held at a lesser cost, and with less stock dilution, when compared with an initial public offering (IPO). While the process of going public and raising capital is combined in an IPO, in a reverse takeover, these two functions are separate. In a reverse takeover, a company can go public without raising additional capital. Separating these two functions greatly simplifies the process.

Resilience to market conditions

In addition, a reverse takeover is less susceptible to market conditions. Conventional IPOs are subject to risk of poor timing: if the market for a given security is "soft", the underwriter may pull the offering. If a company in registration participates in an industry that's making unfavorable headlines, investors may shy away from the deal. In a reverse takeover, since the deal rests solely between those controlling the public and private companies, market conditions have little bearing on the situation.

Expediency

The process for a conventional IPO can last for a year or more. When a company transitions from an entrepreneurial venture to a public company fit for outside ownership, how time is spent by strategic managers can be beneficial or detrimental. Time spent in meetings and drafting sessions related to an IPO can have a disastrous effect on the growth upon which the offering is predicated, and may even nullify it. In addition, during the many months it takes to put an IPO together, market conditions can deteriorate, making the completion of an IPO unfavorable. By contrast, a reverse takeover can be completed in as little as thirty days.

A 2013 study by Charles Lee of Stanford University found that: "Chinese reverse mergers performed much better than their reputation" and had performed better than other similar sized publicly traded companies in the same industrial sector.[6]

Drawbacks

Baggage

Reverse takeovers always come with some history and some shareholders. Sometimes this history can be bad and manifest itself in the form of currently sloppy records, pending lawsuits and other unforeseen liabilities. Additionally, these shell companies could have existing shareholders who could be anxious to sell their stock. One way the acquiring or surviving company can safeguard against the "dump" after the takeover is consummated is by requiring a lockup on the shares owned by the group from which they are purchasing the public shell. Other shareholders that have held stock as investors in the company being acquired pose no threat in a dump scenario because the number of shares they hold is not significant.

Fraud risk

On June 9, 2011, the United States Securities and Exchange Commission issued an investor bulletin cautioning investors about investing in reverse mergers, stating that they may be prone to fraud and other abuses.[1][7]

The 2017 documentary film The China Hustle lays out a series of fraudulent reverse mergers between private Chinese companies and U.S. publicly traded firms, with the acquiring companies often operating as a front for non-existent business activity and defrauding US investors in the process. A large part of these scams was played through small US banks willing to ignore clear warning signs when promoting these newly merged companies to the public market.

Other

Reverse mergers may have other drawbacks. Private-company CEOs may be naïve and inexperienced in the world of publicly traded companies unless they have past experience as an officer or director of a public company. In addition, reverse merger transactions only introduce liquidity to a previously private stock if there is bona fide public interest in the company. A comprehensive investor relations and investor marketing program may be an indirect cost of a reverse merger.[8]

Examples

See also

References
  1. "Investor Bulletin: Reverse Mergers" (PDF). U.S. SEC Office of Investor Education and Advocacy. June 2011.
  2. Goh, Brenda (22 March 2016). "Alibaba-backed courier YTO Express to list via $2.7 billion reverse..." Reuters. Retrieved 9 April 2018.
  3. "Reverse Takeover (RTO) Definition". Investopedia. Retrieved 10 November 2015.
  4. Feldman, David N. (2006). Reverse Mergers: Taking a Company Public Without an IPO. Bloomberg Press. ISBN 978-1-57660-231-7.
  5. Jasinski, Nicholas. "Bill Ackman's Pershing Square Files for Largest-Ever SPAC IPO". www.barrons.com. Retrieved 8 August 2020.
  6. Andrews, Edmund L. (14 November 2014). "Charles Lee: Chinese Reverse Mergers Performed Better Than Their Reputation Suggested". Stanford Graduate School of Business. Retrieved 11 September 2014.
  7. Gallu, Joshua (9 June 2011). "'Reverse-Merger' Stocks May Be Prone to Fraud, Abuse, SEC Says in Warning". Bloomberg.
  8. "Reverse Mergers: The Pros and Cons". Investopedia. Retrieved 10 November 2015.
  9. Bloomberg Business NEws (14 February 1996), "Atari Agrees To Merge With Disk-Drive Maker", New York Times, p. 1 {{citation}}: |last= has generic name (help)
  10. "Frederick's of Hollywood goes public with merger." Reuters. December 19, 2006.
  11. "Dell Technologies Announces Completion of VMware Spin-off". Dell Technologies. 1 November 2021.
  12. "Electric car maker Fisker to go public through SPAC deal at $2.9 billion valuation". Reuters. 13 July 2020. Retrieved 14 July 2020.
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